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For years, the best news an investor could get about a mutual fund was that expenses were being cut.

As a result, investors who see fee cuts today assume the reduction is always good news.
Increasingly, however, expense cuts are becoming a fund company’s way of apologizing for its mistakes, of trying to make up for times when performance may have fallen short of expectations.

Fund reform is forcing companies and directors to be more circumspect about expenses, knowing that the public is more aware than ever that some funds have been generating big revenues for management without ever generating superior gains for investors.

While most investors will probably skip right over the disclosure — and the fund firms will try to muddy it up with jargon and nonsense — the smart money and the class-action bar will not.

Instead, they will be looking for funds where directors are asleep at the switch or in the pocket of management, and one huge sign will be approving the management contract year after year despite below-average performance.

Oppenheimer, for example, recently changed the expense rules on three funds, putting a new performance-oriented kicker into the equation.

According to a prospectus amendment filed on the Oppenheimer Discovery fund, the fund’s manager has agreed to voluntarily cut its advisory fee for any quarter of the coming year in which “the fund’s trailing one-year total return performance, measured at the end of the prior calendar quarter, was in the fourth or fifth quintile of the fund’s Lipper peer group.”

The fee is cut by 0.05 percent for that kind of underperformance, but if the fund finishes in the top 60 percent — the top three quintiles — of its peers, the fee reduction goes away.

A small number of firms — most notably Fidelity Investments — use performance-based fees to determine the size of their pay for running a fund, but the trend is changing, in part because firms like Oppenheimer are using one-year results as the benchmark to determine fee levels.

By linking performance fees to one-year results — instead of three years of performance the way Fidelity has — fund firms pay for a bad year, but can’t get stuck paying for it several years in a row.

That should get more firms to consider performance-based fees.

Directors forced to justify their actions will push the idea, particularly in funds that have been laggards.

There is no better way to wake up management than by taking some money away through an expense cap or cut. One solid way to justify retaining a manager is to be able to show that you got a give-back when performance was below par.

In that way, an expense cut may be something of a misdirect, diverting attention from performance mediocrity to costs.

The key thing to remember is that fund managers usually don’t give investors something for nothing. If they are cutting costs, they have a self-interested reason for doing it and it may be to misdirect you from what has really been going on.

Chuck Jaffe is senior columnist at CBS Marketwatch. He can be reached at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.